In December 2018, the Delaware Court of Chancery issued an opinion holding that federal-forum charter provisions—those that require plaintiffs to bring actions under the federal securities laws in federal court and not in state court—are “ineffective and invalid.”* Sciabacucchi v. Salzberg, 2018 Del. Ch. LEXIS 578 (Del. Ch. Dec. 19, 2018). At that time I wrote: “Assuming that Sciabacucchi is not reversed on appeal, Delaware law allows Delaware corporations to adopt forum selection bylaws or charter provisions governing actions related to the internal affairs of the corporation, but does not allow Delaware corporations to adopt federal-forum provisions governing federal securities law claims.” https://blog.hfk.law/sciabacucchi/ Sciabacucchi has now been reversed by the Delaware Supreme Court. Salzberg v. Sciabacucchi, 2020 Del. LEXIS 100 (Del. Mar. 18, 2020).
A typical federal-forum provision in a certificate of incorporation states that “the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act of 1933.” The Securities Act of 1933, or the ’33 Act, requires companies offering securities to the public “to make full and fair disclosure of relevant information” by filing registration statements with the United States Securities and Exchange Commission (SEC). The ’33 Act created private causes of action for investors and provided that those claims could be brought in state or federal court.
The Delaware Supreme Court found that federal-forum charter provisions “can survive a facial challenge under our law.” The high court rejected the Court of Chancery’s conclusion that “constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.”
The Delaware Supreme Court began its analysis with section 102 of the Delaware General Corporation Law (DGCL), which governs matters that may be included in a certificate of incorporation. Section 102(b)(1) of the DGCL allows two types of provisions:
any provision for the management of the business and for the conduct of the affairs of the corporation,
any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, . . . if such provisions are not contrary to the laws of this State.
The court found that a federal-forum provision “could easily fall within either of these broad categories, and thus, is facially valid”:
The drafting, reviewing, and filing of registration statements by a corporation and its directors is an important aspect of a corporation’s management of its business and affairs and of its relationship with its stockholders.
Thus, federal-forum provisions are permissible under both parts of section 102(b)(1) as to the management of the business and affairs of the corporation and as to its relationship with its stockholders.
The court found that federal-forum provisions “can provide a corporation with certain efficiencies in managing the procedural aspects of securities litigation.” When multiple actions are filed in federal and state court, there is no procedural mechanism for consolidating the cases in a single court, resulting in possible inconsistent rulings and other “costs and inefficiencies.” Federal-forum provisions reduce those effects by requiring all actions to be brought in federal court, where they can be transferred to one jurisdiction and consolidated, or can be handled as a single, multidistrict litigation.
The court based its holding that federal-forum provisions are permissible on Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018), in which the U.S Supreme Court held that class actions based on federal securities laws can be brought in either federal or state court (and cannot be removed to federal court when brought in state court). After Cyan, state-court filings of class actions under federal securities laws “escalated,” with 55 percent more cases filed in state court than in federal court in 2019.
In 2015, the Delaware General Assembly adopted a new section 115 of the DGCL, providing that a Delaware corporation’s charter or bylaws may require “internal corporate claims” to be brought in Delaware courts. The term “internal corporate claims” was defined to include (but was not necessarily limited to) claims of breach of fiduciary duty and claims based on the DGCL. In Sciabacucchi, the Court of Chancery found that federal securities law claims were “external” claims, that section 115 said nothing about external claims, and that it was “understood” that corporate documents could not be used to regulate external claims. The Delaware Supreme Court disagreed, noting that the synopsis to the bill introducing the new section 115 stated that the statute was “not intended to authorize a provision that purports to foreclose suit in a federal court based on federal jurisdiction.” However, federal-forum provisions “do not foreclose suits in federal court”; to the contrary, they direct federal claims to be filed in federal courts. Therefore, federal forum provisions are not inconsistent with section 115.
The appellees argued that section 115 implicitly limited the scope of section 102(b)(1) so as to exclude federal-forum provisions from certificates of incorporation. The Delaware Supreme Court rejected that argument, finding that section 102(b)(1) is “clear and unambiguous” and “does not incorporate Section 115.” The court also found that there is no “irreconcilable conflict” between section 115 and section 102(b)(1) that would cause section 115 to supersede or alter the earlier section. The court harmonized the two sections, finding that section 115 “simply clarifies that for certain claims, Delaware courts may be the only forum, but they cannot be excluded as a forum.”
The Court of Chancery found that federal securities law claims are “external” and therefore cannot be regulated by a certificate of incorporation because “[t]he cause of action does not arise out of or relate to the ownership of the share, but rather from the purchase of the share.” The Delaware Supreme Court rejected that argument too, finding that not all federal securities law claims arise from the purchase rather than the ownership of shares, that existing stockholders can assert such claims, and that other provisions the DGCL “address a number of situations involving the purchase or transfer of shares.” The court found that although securities law claims are not concerned with the “internal affairs” of Delaware corporations, neither are they “external.” Instead, such claims are in an “Outer Band” of “intra-corporate” matters covered by section 102(b)(1) of the DGCL but not within the internal affairs of the corporation.
The Delaware Supreme Court embraced the U.S. Supreme Court’s definition of “internal affairs” as matters “peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders.” Edgar v. MITE Corp., 457 U.S. 624, 645 (1982). However, the Delaware Supreme Court found that section 102(b)(1) allows a certificate of incorporation to regulate matters located in the Outer Band of intra-corporate matters beyond internal affairs. This regulation of Outer Band matters does not violate federal law because the U.S. Supreme Court has held that federal law “has no objection to provisions that preclude state litigation of Securities Act claims” (citing Rodriquez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989)).
Finally, the Delaware Supreme Court found that federal-forum provisions do not “offend principles of horizontal sovereignty” among states, largely because although states are limited in their ability to enact substantive laws that affect other states, forum-selection provisions govern only procedural and not substantive matters. They “regulate where stockholders may file suit, not whether the stockholder may file suit or the kind of remedy that the stockholder may obtain on behalf of herself or the corporation” (quoting Edgar, 457 U.S. at 951–52). As such, they do not “offend sister states [or] exceed the inherent limits of the State’s power.”
The Delaware Supreme Court also noted that federal-forum provisions are less restrictive than Delaware forum provisions because the latter may require stockholder plaintiffs to bring suit far from their home jurisdictions, whereas federal-forum provisions could allow suits to be brought in federal court in any jurisdiction. Nonetheless, combining a Delaware forum charter provision with a federal-forum provision would limit federal securities law claims to the U.S. District Court for the District of Delaware.
Writing in December 2018, I suggested that Delaware corporations should adopt Delaware forum provisions in their certificates of incorporation, but that they could not adopt federal-forum provisions. Now, after the Delaware Supreme Court’s decision in Salzberg v. Sciabacucchi, Delaware corporations can—and should—do both.
* James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery.